The cessation of most U.S. dollar LIBOR tenors has been delayed until June 30, 2023. Aircraft financiers, borrowers and lessors should take advantage of the postponement to prepare for the LIBOR transition.
Borrowers, especially aircraft lessors, should take charge of the process, given their need to align post-LIBOR benchmark replacements among their loans, swaps and operating leases.
The aviation industry should adopt “ hardwired” SOFR-based fallback language and eliminate LIBOR references wherever possible in new financings and leases.

Financial market participants have been anticipating the cessation of LIBOR for several years, with December 31, 2021 originally forecast as the day that LIBOR would be officially discontinued. On November 30, 2020, the ICE Benchmark Administration Limited announced an extension to the date that most U.S. LIBOR tenors (other than one-week and two-week U.S. LIBOR) would cease being announced from December 31, 2021 to June 30, 2023. Aircraft financing contracts are generally denominated in U.S. dollars and often utilize one-month or three-month LIBOR, so this postponement will apply to most, if not all, aviation transactions. This eighteen-month extension is a welcome reprieve for aviation industry financiers, lessors and airlines who have been focused over the past year on the challenges presented by the COVID-19 pandemic rather than the LIBOR transition.

LIBOR replacement provisions in aircraft finance documentation have not evolved much since they first appeared after the announcement of LIBOR’s anticipated discontinuation by the UK Financial Conduct Authority in 2017. Following that announcement, parties to New York law governed aircraft finance transactions generally adopted the Loan Syndications and Trading Association (LSTA) “amendment approach” to the LIBOR transition. This approach contemplates that, upon the occurrence of a trigger event (typically a public statement or publication announcing that LIBOR will no longer be provided or is no longer representative), the loan agreement will be amended to replace LIBOR with a benchmark replacement selected by the agent following the trigger event. Typically, these provisions permit the agent to determine the specifics of these amendments, which are then posted to the lenders and the borrower and become effective within a short period of time thereafter, unless objected to by a majority of the lenders. In some cases, borrowers were successful in negotiating special consent rights with fallbacks based on treasuries or the Federal Funds Rate, plus an agreed spread.

More recently, the Secured Overnight Financing Rate (SOFR), a benchmark interest rate administered by the Federal Reserve Bank of New York, has been recommended by the Alternative Reference Rates Committee (ARRC) as the preferred successor to LIBOR in U.S. dollar financings. This recommendation has been embraced by the LSTA and, to a large extent, commercial lenders and borrowers. That said, the approach is not without its challenges. Unlike LIBOR, SOFR is an overnight rate, and is not forward-looking. The ARRC and LSTA anticipate that forward-looking term SOFR rates will emerge to fill the void created by the discontinuation of LIBOR, but this has not happened yet and so uncertainty around the nature of a SOFR-based rate, and post-LIBOR commercial loans, remains. Additionally, SOFR is generally lower than LIBOR because it is a secured and so-called “risk-free” rate, whereas LIBOR is unsecured and therefore includes a credit risk premium. LIBOR-based loans transitioning to a SOFR-based rate, whether it be a term rate or a daily compounded rate, will therefore need to incorporate a spread adjustment. For purposes of incorporating fallback language in loan documents today, the AARC and the International Swaps and Derivatives Association have recommended a spread adjustment based on the median difference between LIBOR and SOFR over a five-year lookback period occurring prior to a LIBOR transition event.

In August 2020, the ARRC announced that “hardwired” fallback language, rather than the “amendment approach” should be used in all new syndicated business loans starting in September 2020 and in all new bilateral business loans starting in October 2020. The “hardwired” approach sets out a hierarchy of fallback rates—first, a forward-looking term SOFR rate, if available, second, a compounded daily SOFR rate, and third, an alternative rate selected by the agent and the borrower after giving consideration to any recommendations by relevant governmental authorities or then prevailing market practice. At the time of writing, the hardwired approach is not figuring prominently in new aircraft financing transactions, although bank-originated deal flow since the onset of the COVID-19 pandemic has been substantially lower than in prior years, which has understandably slowed the pace of changes to market practice. A low interest rate environment has also led borrowers in new financings to lock in attractive fixed rates rather than adopt a LIBOR-based floating rate. That being said, market surveys indicate that the hardwired approach is gaining steam in the broader commercial lending market, and we expect that aircraft financing transactions will soon follow.

What Actions do Aviation Industry Participants Need to Take?

With the benefit of an extra eighteen months to prepare for the LIBOR transition, what actions should financiers, lessors and airlines take?

  • Audit existing transactions to identify those requiring amendment. While the ARRC projected that the extension of LIBOR to 2023 would allow most legacy transactions to mature before LIBOR is discontinued, that will unfortunately not be the case for a significant number of existing aircraft financing transactions, many of which, particularly new delivery financings, have terms extending up to ten or twelve years. As a first step, parties should review their transactions and identify those that mature after June 30, 2023, and, among those, which are floating rate or otherwise reference LIBOR in some respect. Where the documents incorporate the “amendment approach” to the LIBOR transition, the LIBOR replacement provisions should be reviewed to determine to what extent the agent can determine and implement the new benchmark independently, or where the borrower has consent or other negotiation rights, and parties should start the conversation about the upcoming amendments now.
  • Borrowers, particularly lessors, should take the reins. Borrowers should not assume that their lenders will dictate the path forward and will benefit from controlling the process given their potential exposure to LIBOR on multiple fronts— financings, swaps and operating leases. Aircraft lessors, in particular, should seek to take charge of the process, and develop a defined approach to managing the transition with their financiers, swap providers and lessees. Post-LIBOR benchmark replacements will need to be aligned among their loans, hedges and leases in order to avoid potential mismatches in the timing of implementation, structure and pricing of new benchmarks.
  • Identify and engage with all relevant counterparties now. Aircraft finance transactions are complex and often involve a large number of parties, including commercial banks, lessors, private equity and other investors, export credit agencies, airlines and corporate guarantors. Coordination and agreement among the various transaction parties will often be needed, particularly where the documents do not establish a mechanism for amending LIBOR provisions. Particular attention will need to be paid to warehouse financings and other portfolio transactions where the number of contracts and counterparties necessarily involved in the amendment process can be significant. These deals can often involve a large syndicate of lenders as well as hedge providers and a myriad of lessees under operating leases with varying terms.
  • Eliminate LIBOR references where possible in fixed rate deals and operating leases. Lessors with a pipeline of new aircraft often enter into operating leases years in advance of delivery with an agreement that the rent amount will be fixed shortly before delivery based on manufacturer escalation rates and swap rates, which are sometimes LIBOR-based. LIBOR references may also appear in contractual provisions outside of those dealing with the accrual of interest and calculation of rent. Examples include default rate definitions, make-whole provisions (i.e. for purposes of determining the discount rate used to calculate the present value of payments or otherwise) and formulas for calculating notional fixed rate breakage. During the LIBOR transition, parties should consider adopting flat rates, or rates based on the prime rate or the Federal Reserve’s federal funds rate, as alternatives for LIBOR-based rent-fixing formulas, default rates and discount rates. With respect to notional fixed rate breakage, the lender’s funding sources should be considered. If the lender’s funding costs are not based on LIBOR, then references to LIBOR in the fixed rate breakage calculations should be omitted and replaced with provisions more precisely tailored to the lender’s funding source and associated costs.
  • Adopt “hardwired” fallback language in new floating rate financings. Regulators, including the Federal Reserve, the OCC, and FDIC have stressed that, notwithstanding the postponement of LIBOR’s discontinuation to 2023, market participants should cease entering into new USD-LIBORbased contracts after December 31, 2021, at the latest, warning that the failure to do so would create “safety and soundness risks” for the financial system. Leading industry players should commence implementing the “hardwired approach” promulgated by the ARRC. The LSTA has published model credit agreements with comprehensive provisions implementing the hardwired approach, including alternative approaches to calculating SOFR-based interest (i.e. daily simple SOFR, compounded SOFR and (if it becomes available in the future) term SOFR), as well as different methodologies for compounding and implementing spread adjustments. By implementing this approach in their contracts going forward, parties can minimize disruption when LIBOR is officially discontinued. Lessors should be sure to harmonize fallback language across their financing, swap and lease documents, to ensure that transitions to SOFR occur simultaneously and that there is no potential for a mismatch.

Aviation industry professionals must act quickly to devise and implement a strategy for the LIBOR transition, starting with a thorough internal audit of existing contracts and forms. While many would prefer that a clear market practice emerge in aircraft finance and leasing transactions before implementing a SOFR-based interest rate across their loans and leases, the imperative of achieving an orderly transition to a post-LIBOR world requires that all parties commence the process of transitioning their contracts now. The ARRC, ISDA and the LSTA have laid the groundwork, and the aviation finance and leasing industries must now start the work of implementing the transition, by adopting the “hardwired approach” to new LIBOR-based deals, eliminating unnecessary LIBOR references from fixed rate contracts, and devising a strategy to amend existing deals. By starting to plan for the transition today, lenders, borrowers and lessors will reap the most benefit of the eighteen-month extension to the life of LIBOR.

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